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16-2 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Dividend Policy
Introductory concepts – does it matter
how shareholders get their returns?
Dividend theories
Dividends in practice
How a dividend is paid
16-3 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Dividend Policy
Introductory concepts – does it matter
how shareholders get their returns?
Dividend theories
Dividends in practice
How a dividend is paid
16-4 © 2002, 2012 Frank M. Werner and James A.F. Stoner
How Shareholders Get Their
Returns
Dividend – a payment made by a
corporation directly to its stockholders
Dividends are one of two ways
shareholders get returns – the other is
stock price appreciation
16-5 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Does it Matter How Shareholders
Get Their Returns?
The effect of raising the dividend
– Other things equal, increasing the dividend should
raise the firm’s stock price
– However, if a dividend increase leads investors to
raise their required rate of return or lower their
growth forecast, increasing the dividend could
lower the firm’s stock price
The critical question – does a dividend
paid today change investors’ forecasts of
future dividends or required rate of return?
16-6 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Dividend Policy
Introductory concepts – does it matter
how shareholders get their returns?
Dividend theories
Dividends in practice
How a dividend is paid
16-7 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Theories That Argue for the
Payment of Dividends
Risk reduction theories
– Payment of a dividend resolves some uncertainty
about the amount and timing of returns
– Changes in dividends convey valuable
information about the company’s future
– Dividends increase investors’ liquidity
16-8 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Theories That Argue for the
Payment of Dividends
Market imperfection theories
– Dividends broaden the demand for the firm’s
stock since some institutional investors are
restricted to buying shares of dividend-paying
companies
– The tax code makes paying dividends attractive
to:
• corporate investors – 70% of dividends are tax free
• companies at risk for “improper accumulation”
16-9 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Theories That Argue for the
Payment of Dividends
Efficiency theory – dividends give
investors the freedom to reinvest their
returns in other companies, improving the
allocation of invested capital
16-10 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Theories That Argue Against
the Payment of Dividends
Supply-demand theory – selling fewer
new shares avoids increasing the supply
and lowering their price
Market imperfection theories
– Not paying dividends avoids processing costs
– Not paying dividends avoids the flotation costs
of issuing additional shares
– Not paying dividends avoids exposing
shareholders to double taxation
16-12 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Theories That Argue Against
the Payment of Dividends
Control theory – not paying dividends
avoids dilution of ownership and control
Sustainable growth theory – not paying
dividends permits the firm to grow faster
before having to sell additional shares
16-13 © 2002, 2012 Frank M. Werner and James A.F. Stoner
A Theory That Concludes
Dividends are Irrelevant
Modigliani and Miller:
– Payment of a dividend merely reallocates
investors’ value from the company to the
investor
– “Homemade dividends” – an investor who is
unhappy with the dividend can:
• buy a few shares with the dividend money to return it
to the firm
• sell a few shares to take more money out of the firm
16-14 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Theories That Argue for
Consistency
Clientele theory – Investors choose to invest in companies with
dividend policies they prefer
– Over time, a company’s investors will reflect its dividend policy, not vice versa
– Therefore: any dividend policy will do, just don’t change it
Market imperfection theories – It is difficult to home-make dividends when the
price of a share is very high
– The transactions cost for small share purchases or sales is proportionately high
16-15 © 2002, 2012 Frank M. Werner and James A.F. Stoner
A Theory That Argues Against
Setting a Dividend Policy
Residual theory
– Set retained earnings, not dividends
– The residual approach
• Determine the need for new financing
• Determine how much of this new financing should
come from equity
• Use retained earnings to the greatest extent possible
• Make the dividend whatever is left over from the
year’s earnings
16-16 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Dividend Policy
Introductory concepts – does it matter
how shareholders get their returns?
Dividend theories
Dividends in practice
How a dividend is paid
16-17 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Dividends in Practice
Stability of payments
– Stable payout ratio
– Stable dollar dividend
– Stable dollar dividend plus a year-end bonus
payment
Company maturity – stage in life cycle
– Birth – low dividends due to limited cash
– Rapid growth – low dividends due to needs
– Maturity – high dividends to provide returns
16-20 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Dividends in Practice
Other practical considerations
– Availability of cash
– Alternative uses of cash
– Access to banks and financial markets
– Shareholder preferences
– Legal or charter restrictions
16-21 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Dividend Policy
Introductory concepts – does it matter
how shareholders get their returns?
Dividend theories
Dividends in practice
How a dividend is paid
16-23 © 2002, 2012 Frank M. Werner and James A.F. Stoner
How a Dividend is Paid
Four dates
– Date of declaration – board of directors votes to
pay the dividend
– Date of record – company looks at its
shareholder list to determine who receives the
dividend
– Ex-dividend date – stock-exchange ensures that
those who purchase shares after this date do not
receive the dividend
– Payment date – dividend checks are mailed